OIL SINKS, GAS LIFTS

Saudi Arabia and Russia are playing a game of chicken with the price of oil. After collaborating for a while in the cartel that came to be known as OPEC Plus, Russia did not agree to production curbs, even with the Saudis carrying most of the water. The Saudis dropped their price to gain market share. Today (March 11, 2020), the US benchmark West Texas Intermediate plummeted to USD 32 from about USD 60 at the start of the year. This is a light oil. Heavy crude, as from Canada, carries a discount in the vicinity of 25%. Many operations, especially those heavily leveraged with debt, will be unsustainable.

Two factors are in play here. The COVID-19 inspired reduction in industrial output and dampener on travel already put downward pressure on oil. The Russia-Saudi spat merely poured fuel on the fire. Russian breakeven price is USD 40, and the Saudi one is USD 80 (due to social costs; the production cost is in low single digits). So, logic dictates this situation to not be long lived. Even if one of them blinks, the other factor will still depress oil usage.

The associated recession is different from that in 2008. Low demand was the big issue then. This time the demand, spurred by low unemployment, is present and the supply is the issue, driven in large measure by China producing less goods during the COVID-19 crisis.

An interesting aspect of the situation is that one could expect natural gas prices to rise. They have been depressed due to oversupply. Excessive natural gas production has been an unintended consequence of shale oil production. This oil, being very light (mixture of relatively small molecules) has a proportion of even smaller molecules associated with it. These molecules are methane, ethane, propane and butane, in the main. Collectively, these are known as wet natural gas. The hot (perhaps not for long) Permian basin produces 2.2 billion cubic feet per day (bcfd) of this stuff with each 1.0 million barrels per day (bpd) of oil. Until recently, the US was adding 1 million bpd of oil annually. That additional “associated” gas was softening the gas market. Expectation of continued shale oil increase heralded continued softness. All that may change now.

The print edition of the New York Times (March 10, 2020, B1) has a story on the oil standoff and the impact on US shale oil. Curiously, an associated image is that of Shell’s partially constructed ethane cracker in Beaver County, PA (the product will be ethylene and associated plastics). By implication (there is no explanation in the text) this will be compromised. On the contrary, it is likely to command more guaranteed feedstock. Ethane is a biproduct of “wet” shale gas, which is plentiful in that portion of western PA. Shale gas development will likely get a lift from the firming of prices, and wet gas is more profitable. That means more ethane supply for the cracker. And possibly at lower prices; natural gas liquids prices are usually pegged to oil price.

In an odd twist, the Saudis announced a major entrée into shale gas production. With 200 trillion cubic feet in reserves, they plan to produce 2.2 bcfd of shale gas by 2036. This appears to be very wet, with 10 gallons NGL per mcf gas, which places it on the higher end of the richness scale of US deposits. The liquids will be used to make chemicals, while the dry gas is destined to be burned for power. That is the principal driver: to replace about 800,000 bpd of oil currently used to generate electricity. That oil will now be available for export, adding to the glut (when it happens). Shale oil has been a thorn in the side of the Saudi led OPEC. Now, the Saudis plan to use the underlying technology to make more of their oil available for export. US service companies will be doing the work. Ironies abound.

Vikram Rao

March 11, 2020

PS The blog is back!!

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§ 3 Responses to OIL SINKS, GAS LIFTS

I think it is a bit naive to think that this is just Russia vs KSA duel when US shale oil stole from otherwise OPEC+ market share over 4 MMBOD.
This is a direct and deliberate attack to US shale sector. Both know this attack if short lived won’t achieve its objective of damaging US shale producers. So I expect Russia and KSA will have to wait until US Shale is seriously hurt. What this means is that excess oil from OPEC+ will be in the market driving prices to $20s.
Also there is a political angle to this. President seem to favor low oil prices that means less cost at the pump stations for Americans but that has another edge which if the US shale producers impacted as intended the entire sector will have to fire tens of thousands of work force in Texas ND OK and many other states.

The real response from the US shale sector to this attack may have to come from an agreement between services sector and the producers: when oil prices are lower cost of services are lower and goes up so does the cost of services. If somehow service cos and producers find a formula to lower cost to $20s then we should expect the kingdoms in KSA and in Moscow to shake up.

Could not agree more; this is the second attack on US shale oil, but abetted by the COVID-19 driven economic downturn. Also agree that for US shale oil to survive, a concerted attempt has to be made to drop the breakeven cost. And yes, it may take cooperation between service and oil companies. The consolidation of ownership of shale assets into major oil companies (likely to continue even more now) could help. In the end, innovation has to solve the problem. As Nietzsche said “was mich nicht umbringt, macht mich stärker” or roughly in English, “that which does not destroy me, makes me stronger”!